Bitcoin Tax Guide: Trading Gains And Losses - Fair Market Value

The basic long-term and short-term capital gains treatment for Bitcoin may sound simple enough; but the truth is, many speculators who have been drawn to Bitcoin's price movements are active traders who will have difficulty calculating their cost bases. How should Joe Consumer (or any investor) track his cost basis when Bitcoin's fair market value has varied as widely as 20% between exchanges and 50-100% on some days in 2013 (based on data from http://bitcoinity.org/markets/)?

If Joe bought and sold Bitcoins exclusively through third-party exchanges like Bitstamp (chief competitor of the now-defunct Mt. Gox) or hosted wallets like the San Coinbase, his transaction history and corresponding cost basis may be easier to calculate. But let's assume that in the absence of a ubiquitous U.S-trading platform in 2013, he took it upon himself to calculate the fair-market value of his cash trades through acquaintances at his local meet-up or through barter transactions with his friends or Bitcoin commerce with neighborhood merchants.

Few, if any, of Joe's counterparties are likely to have established personal or merchant accounts capable of handling this tax reporting for themselves, much less for Joe as well.

Luckily, the IRS only requires that taxpayers report the fair-market value of their Bitcoin on the date that the currency was received. So as long as Joe determines his fair-market value in a "reasonable manner which is consistently applied," he has a considerable amount of leeway in determining his various cost bases. For instance, it might be fine for him to determine the fair-market value of any given purchase using that day's high price at Mt. Gox, provided that he didn't then use the daily low at, say, Bitstamp as the reference price on his sales (artificially reducing his tax liability).

In theory, any fair-market value reported by a taxpayer disposing of Bitcoin should serve as the new cost basis for the new taxpayer acquiring Bitcoin; it does not matter whether the acquirer is a merchant or an individual. However, in practice there is no way to ensure consistent reporting, and many taxpayers like Joe may report conflicting cost bases that are most tax advantageous to themselves. In still other cases, it may be difficult or even impossible to determine a fair cost basis. What is the fair-market value for a newly created currency that may not yet trade on exchanges?